It's really interesting to me how a decade into the housing bust, there is still a lot of public commentary based on the idea that a housing bubble is the defining element of our time, discussions based on the concern that we are entering a new bubble (sometimes based on the idea that rents are rising!), comments that there is a lot of visible construction activity in one city or another (much of this is commercial), and comments on macro-policy that we can handle cutting down on nominal incomes a little bit because the housing sector is now on solid footing.
It's a peculiar set of mental adjustments we are making here. We have normalized our perceptions to the new reality of the bust without removing the overriding idea that we were, and are still, in, or at risk of, a bubble. I think, largely, people simply haven't registered the scale and timeframe of what has happened since 2006. My project for most of this year has been on a path leading away from the notion that there ever was something we could call a bubble. But, even for anyone who may still believe that 2001-2005 reflected some departure from a sustainable level of construction activity, the scale of the ensuing bust dwarfs anything that happened before 2006. If we simply have an unbiased reaction to deviations from long-term trends, then any reaction to the boom should be doubled or tripled as a reaction to the bust. We should be marching in the streets for pro-building, pro-lending policies. We should be "Occupying Wall Street" to open up the vaults and issue mortgages.
Calculated Risk references a new report from the Mortgage Bankers Association about housing demand in the next decade. As McBride points out, there should, conservatively, be demand for 1.5 million new units per year. We are currently back up to about 1.1 million per year. First, here is a basic chart of annual changes in population in the U.S. The MBA report has much more detail on demographics and population. There has not been, nor is there an imminent decline in population growth relative to previous eras. Population growth and household formation have been lower after the crisis than they were before the crisis. There have been many hypotheses about that, including changing cultural norms for millennials, anxiety about homeownership because of the bust, general economic malaise, etc. The false notion that we had overbuilt housing in the 2000s seems to keep the most obvious problem from being widely noted. We don't have enough houses. We have undermined the mechanisms that households would utilize to create housing. It's hard for households to form it there aren't houses.
Here is a chart of housing starts, going back to 1959. That 1.5 million unit level mentioned by Bill McBride goes back to the beginning of the data series. If we track housing starts all the way up to July 2003, the long term trend is a dead flat 1.521 million units per year, for 44 years. Housing starts had been unusually below trend in the late 1980s and early1990s. Even though some rumblings about housing bubbles had begun as early as 2001, housing starts even into 2003 were not very far above that long-term average, and the 10 year moving average was pretty close to that long-term average.
Even if we look at the entire period through 2005, total housing starts were not particularly high compared to previous expansions. But, if we create a discontinuity at July 2003, where housing starts had recovered enough to pull the long-term trend back to level, and look at housing starts in the 12 years since then - including both the "bubble" period and the bust period - average starts have come at an average rate of 1.166 million per year. That adds up to about 4 million homes missing from the U.S. economy.
If the drop in household formation has been more a result of the housing bust than a cause of it, there is a lot of catching up to do. The MBA report notes this, to an extent, but to the extent that the bubble narrative is pulling down expectations, I think even their numbers may be understated. Looking at my graph of housing starts, the drop in starts is unprecedented and extreme. Even now, we have really only recovered back to what would have previously been considered extreme recessionary building levels - and this is after nearly a decade of levels well below any previous experience. The scale of the hole we have blown in the American housing stock should be shocking.
I have appended a hypothetical future building level onto the graph, which represents 3% monthly growth (over 40% annual) until starts reach 2 million per year. This would have to be the case until 2023 just to pull the long-term trend back to a level 1.5 million. It would be 2021 before the 10 year moving average of housing starts moved above 1.5 million in that scenario. The boom we need just to regain previous generations' levels of housing availability would need to be much larger than what we saw in the 2000s. We would need 2005 level housing expansion for 7 years. In short, sadly, the level of housing construction this country needs is massively more than we will ever allow.
Real housing expenditures, as estimated by the BEA, have been falling since the early 1980s, compared to other personal consumption expenditures. One natural counter-reaction to my argument would be to wonder if the natural trend of housing starts has been declining instead of remaining level, which would cause the bust to be overstated. Considering demographic and population trends, and the fact that rent inflation began to run persistently above core inflation in the mid-1990s, only moderating during the top of the boom in 2004-2005, it is more plausible that the long-term trend housing actually should have been rising during this period.
Some of the housing growth required to make up that additional shortfall would come through housing starts. But, much of it would come through higher home values (in terms of rental value). That doesn't necessarily mean that American households need larger homes, though some wouldn't mind having larger homes. Much of that value would be location value. That is tied to our urban core regulatory problems. That is a whole different problem. Until we solve that problem, the houses we build will be in second-best locations where building is welcomed.
But, whether we solve this problem with second-best housing units in Arizona and Nevada or with housing units in San Francisco and New York City, we have a heckuva lot of houses to build.